Floating Rate bank loans appear to be attractive as the Federal Reserve readies to raise interest rates.
Bank loans are debt instruments of non-investment grade rated companies (BB and below) that are bundled by banks and sold to institutional investors, including to mutual funds. The yield on these securities moves up or down with the level of short-term interest rates. This floating rate feature historically has allowed the asset class to perform well when interest rates are rising.
Today, the average bank loan price is near $90 approaching the lowest level of the past decade outside of the financial crisis (chart). With room for prices to rise toward par ($100), we believe this sector could benefit if the economy remains solid and interest rates rise. Yields on many bank loan mutual funds are between 4-5%.
Investors should be aware that because bank loans represent lower quality debt instruments, they may perform poorly during an economic downturn. Therefore, bank loan should be viewed as one part of a broadly diversified fixed-income portfolio. Furthermore, we recommend that investors only consider investing in this asset class through a conservatively managed, broadly diversified mutual fund.